Abstract
We evaluate the relative importance of aggregate labor productivity versus income taxes and social contributions for tax compliance in an economy with a large degree of informality. Empirical evidence points out that tax evasion in Europe happens through partially concealing wages and profits in formally registered enterprises. To this end, we build a model in which employer-employee pairs of heterogeneous productive capacities make joint decisions on the degree of tax evasion. The quantitative model is used to analyze the case of Bulgaria which has the largest informal economy in Europe and underwent a number of important tax reforms over the period 2000–2014, including the introduction of a flat income tax in 2008. The estimation strategy relies on matching the empirical series for the size of the informal economy and other aggregate outcomes for 2000–2014. Our counterfactual experiments show that the most important factor for the changing size of the informal economy is labor productivity, which accounts for more than 75% of the change. The variation in corporate income tax accounts for the rest. We find that the 2008 flat tax reform did not play any visible role in coping with informality.
Funding source: Global Development Network
Award Identifier / Grant number: RRC1437
Funding statement: This research is supported by research grant RRC1437 from the CERGE-EI Foundation under a program of the Global Development Network.
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Article Note
The paper was previously circulated as “Productivity, Taxation and Evasion: An Analysis of the Determinants of the Informal Economy”. We are grateful to Philippe Aghion, Carlos Carrillo-Tudela, Marco Maffezzoli, Xavier Ragot, Stephanie Stantcheva, Colin Williams, Todor Yalamov and seminar participants at the GDN Regional Conference in Prague, the University of Konstanz, the Marie Curie/IAPP Informal Economy Conference in Sofia, the Summer School at Balkanski-Panitza Institute for Advanced Study (BPIAS), the T2M Conference in Lisbon (2017), the ZEW Public Finance Conference (2017) and the EEA Conference (2018) for insightful comments. Veronika Georgieva and Angelina Nazarova are thanked for providing excellent research assistance.
Supplementary Material
The online version of this article offers supplementary material (DOI: https://doi.org/10.1515/bejm-2018-0252).
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